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September 13, 2012

Fed Launches QE3 With Open-Ended Security Purchases

‘This is not very bold in my opinion,’ LPL Financial strategist says

Fed Chairman Ben Bernanke. (Photo: AP)

The Federal Reserve has launched a third round of quantitative easing, pledging to expand its balance sheet by nearly a half a trillion dollars a year beyond existing commitments.

The Fed concluded its two-day policy meeting with a commitment to purchase mortgaged-backed securities at a rate of $40 billion per month. Together with earlier announced bond purchases, the Fed’s move will increase “holdings of longer-term securities by about $85 billion each month through the end of the year,” the Fed announced Thursday.

Citing persistent weak labor-market conditions and continued global financial turmoil, the Fed says its monetary easing “should put downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative.”

Notably, the easing decision apparently contained no limit as to how much the Fed was willing to invest in securities. Rather, the Fed’s accommodation policy appeared to be open-ended:

“If the outlook for the labor market does not improve substantially, the committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability,” the Fed’s announcement stated.

At a press conference Thursday afternoon, Fed Chairman Ben Bernanke fielded a number of questions from reporters about the open-ended nature of monetary easing, saying, “We’re not going to be premature in removing policy accommodation… We’re going to give it some time to make the sure the recovery is well established.”

The Fed chairman said such a policy could not be sustained until the economy returns to full employment, but said “we’re going to be looking for signs the economy is strong enough” to withdraw support.

The other major news emanating from the Fed’s announcement was an extension of the duration of the Fed’s “zero-rate” policy. The Fed now says its will keep rates between zero and 0.25% “at least through mid-2015,” from its previously stated late 2014 pledge.

Markets reacted mostly positively to the Fed move Thursday. The S&P 500 surged by more than 1.6% and prices rose for mortgage-backed and agency securities and Treasury notes. But longer-dated bonds fell over inflation fears; prices for 30-year debt sank and fell most of the day for the benchmark 10-year Treasury, though the latter turned moderately positive at day's end.

“Ultimately, this doesn’t really change the picture for Treasuries. This is not very bold in my opinion,” he said.

Valeri noted that could change, though, as occurred with the first round of quantitative easing, where a massive $1.25 trillion purchase of mortgage-backed securities was followed months later by a large-scale purchase of Treasury bonds.

Still, Valeri questioned the potential effect quantitative easing might have at this stage.

“With yields already at or near record lows, can the Fed really do much more? At the margin this is helpful, but this is going to be less impactful” than the first and second rounds of quantitative easing, he said.

In Bernanke’s press conference, he said the Fed’s easing “is not a panacea,” but is aimed at staying “accommodative long enough to ensure recovery.”

All members of the Federal Reserve Board of Governors except for the Richmond Fed president, Jeffrey Lacker, voted for the new round of quantitative easing and zero-rate extension.

Since the start of the financial crisis in 2007, the Fed has more than tripled the size of its balance sheet from $897 billion to $2.87 trillion today.

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Check out this enlightening, but scary, economic scenario in The End of Growth? on AdvisorOne.

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